Focus on Funds: Investors ditch UK equity funds

According to the latest fund sales figures from the Investment Association (IA) investors are selling UK equity funds as coronavirus and Brexit deliver a double whammy to the economy and dividends dry up.

£1 billion was withdrawn in June alone with the UK All Companies sector the worst performer, with £662 million of outflow, while UK Equity Income saw £327 million removed from funds; this is a complete reversal for UK funds from December when UK All Companies was actually the best-selling IA sector.
 

The IA’s findings were echoed by a Bank of America Merrill Lynch survey of fund managers in July which also found the UK market is unpopular with asset allocators.

There are believed to be three key factors fuelling UK funds’ current unpopularity:
 

Brexit and the pandemic

As we learn that coronavirus has plunged the UK economy into its deepest ever recession, Britain also faces a potential double whammy as the end of the Brexit transition period approaches.

James Menzies, investment director at Greystone Wealth Management, told interactive investor that Brexit uncertainty has been a strong driver of outflows from UK equity funds.

‘The key reason is that renewed uncertainty around the Brexit process is coming back into focus. This has been out of the political headlines over the past few months due to the coronavirus outbreak, but negotiations between the UK and European Union have still been going on in the background – with very limited progress being made on a trade agreement. There is concern among some investors that a disorderly withdrawal from the EU at the end of this year will compound the hit the UK economy will take from the coronavirus pandemic.’

Mr Menzies has also reduced exposure to the UK market, but retains a presence with the firm’s multi-manager portfolios where he sees attractive valuations in mid- and small-cap stocks.

‘The UK equity managers we invest in focus on high quality businesses with good cash generation and strong competitive advantages. These companies would be expected to perform well versus peers in the event of weak economic growth,’ he added.
 

UK missed the lockdown tech wave

The rebound in global markets since March has seen sectors such as IT, healthcare and e-commerce perform well as companies embrace digital communication, and locked-down consumers shop online; for obvious reasons money has poured into vaccine research.

However, the so-called ‘Zoom effect’ has failed to make any great impact on the UK’s main market because the FTSE 100 is largely made up of cyclical sectors such as financials, basic materials and energy; investors have turned away from these sectors as Covid-19 puts the economy under increasing pressure.

Because the UK is under-represented in sectors that have thrived in lockdown compared with, for example, the US, it has lagged the recovery.
 

Disappearing dividends

The UK has traditionally been a happy hunting ground for income investors, but dividends have dried up with 445 companies listed on the LSE either cancelling, cutting or postponing dividend payments.

Alex Moore, head of collectives at of Rathbones told interactive investor: ‘Income investors in particular have had a bad experience due to Covid-19, before 2020, the UK had one of the most generous yields of all markets around the world, but a large number of companies are now cancelling or cutting dividends and giving as little guidance as possible due to the uncertainty on Covid-19 on future earnings. We are now seeing investors that were reliant on income streams via dividends selling as they are no longer getting the dividends they once were.’
 

What will see the UK build, build build?

For investors to return to the UK market once more, some clarity around Brexit would be welcome, and particularly around a trade deal with the EU. ‘The markets like certainty, and a more clear-cut situation around ‘deal or no deal’ – deal, preferably – might bring enough certainty to encourage investors back to the UK,’ said Mr Moore.

Another key driver could be the return of banks paying dividends after the regulator told them to suspend dividends at the end of March; banks were told build capital buffers to be able to absorb Covid-19 losses and continue to lend. UK equity income may become attractive once again when these banks reinstate their payouts.

Furthermore, an improvement in the global macro environment could benefit oil and basic materials companies; however, weaker sterling in the event of a macro shock, could benefit FTSE 100 companies that earn most of their revenues in dollars and make the UK equity market look attractive to investors once more.